T.C.
ISTANBUL AYDIN UNIVERSITY INSTITUTE OF SOCIAL SCIENCES
THE EFFECTIVENESS OF FOREIGN AID TO POVERTY TRAP IN TERMS OF POOR COUNTRIES – CASE OF AFGHANISTAN
THESIS
Jalil Ahmad Ghazizada
Department of Business Business Management Program
Thesis Advisor: Dr. Ögr. Üyesi Cigdem OZARİ
T.C.
ISTANBUL AYDIN UNIVERSITY INSTITUTE OF SOCIAL SCIENCES
THE EFFECTIVENESS OF FOREIGN AID TO POVERTY TRAP IN TERMS OF POOR COUNTRIES – CASE OF AFGHANISTAN
THESIS
Jalil Ahmad Ghazizada Y1512.130037
Department of Business Business Management Program
Thesis Advisor: Dr. Ögr. Üyesi Cigdem OZARİ
DECLARATION
I hereby declare that all information in this thesis document has been obtained and presented in accordance with academic rules and ethical conduct. I also declare that, as required by these rules and conduct, I have fully cited and referenced all material and results, which are not original to this thesis.
ACKNOWLEGMENT
First of all I want to extend my genuine gratitude to my supervisor Assist.Prof.Dr Çiğdem ÖZARI who has helped me all over my dissertation with her tolerance and knowledge.
Secondly, I would like to express my sincere thanks to my lovely mother and father for their eternal love, supports and encouragement. I am heavily indebted to my brother Mr. Jamil Ahmad Ghazizada, who was supporting and believing on me since the very beginning.
Additionally, I would like to thanks to my dearest friend Xin Zhao and Pamir Hazem for their useful guidance, directions and motivation which made this study possible. Finally, last thanks go to all professors and friends whoever thought me a word.
May, 2019 Jalil Ahmad GHAZIZADA
TABLE OF CONTENT
Page
ACKNOWLEGMENT ... iv
TABLE OF CONTENT ... v
ABBREVIATIONS ... vii
LIST OF FIGURES ... viii
LIST OF TABLES ... ix ABSTRACT ... x ÖZET ... xi 1. INTRODUCTION ... 1 1.1 Importance of Research ... 4 1.2 Research Objective ... 4 1.3 Research Questions ... 5 1.4 Research Implications ... 5 1.5 Research Hypotheses ... 5 2. LITERATURE REVIEW ... 7 2.1 Defining Aid ... 7
2.2 Official Development Aid ... 9
2.3 The History of Official Development Assistance ... 9
2.4 Paris Declaration on Aid Effectiveness ... 13
2.4.1 Ownership ... 14
2.4.2 Alignment ... 14
2.4.3 Harmonization ... 15
2.4.4 Managing for results ... 15
2.4.5 Mutual accountability ... 15
2.5 Accra Agenda for Action ... 17
2.5.1 Country ownership ... 18
2.5.2 Building effective partnerships for development ... 19
2.5.3 Gaining development results ... 19
2.6 Important Items of AAA from Afghanistan’s Perspective ... 19
2.6.1 Country’s ownership over development ... 20
2.6.2 Building of country’s institution ... 20
2.6.3 Poverty ... 20
2.7 Poverty reduction ... 21
2.8 Aid-Poverty Relations ... 22
2.8.1 Theoretical link between foreign aid and poverty... 22
2.8.2 Vicious and virtuous cycles ... 22
2.8.3 Stages of economic growth theory ... 24
2.9 Harrod-Domar and Gap Models ... 25
2.9.1 Foreign aids ‘channels effecting on poverty trap ... 27
2.9.2 Growth channel ... 28
2.9.3 Pro-poor public expenditure channel ... 29
2.10 Afghanistan country profile ... 30
2.11 Afghanistan’s National Development Strategy (ANDS) ... 36
2.12 The Impact of Foreign Aid in Afghanistan ... 37
2.13 Aid Effectiveness in Afghanistan ... 37
2.14 Research Gaps ... 38
3. RESEARCH METHODOLOGY ... 40
3.1 Study Model ... 40
3.2 Data of the study ... 41
3.3 Statistical Methods ... 42
3.4 Multiple Regressions ... 42
3.5 Stationary Tests ... 43
3.6 Co-integration Test ... 43
3.7 Lagged Variables ... 44
3.8 Ordinary Least Square – OLS ... 44
3.9 Justifications for using the Method of Least Squares: ... 45
3.10 Data Analysis ... 45
4. ANALYSIS ... 46
4.1 Descriptive Analyses of the Variables ... 46
4.1.1 (y) Households and NPISHs Final consumption expenditure per capita growth (annual %) ... 46
4.1.2 (𝒙𝟏(: Subsidies and other transfers (current LCU) ... 47
4.1.3 (𝒙𝟐) Debt forgiveness grants (current US$) ... 48
4.1.4 (𝒙𝟑) Grants and other revenue (% of revenue) ... 49
4.1.5 (𝒙𝟒): Net ODA received per capita (current US$) ... 49
4.2 Time series Statistic Test ... 50
4.3 Co-integration Test of Study Variables ... 51
4.4 The Result of the Study Model ... 52
4.5 Diagnosis Results of the Estimated Study Model ... 54
4.5.1 The coefficient of determination and the significance of the model ... 54
4.5.2 Autocorrelation test ... 55
4.5.3 Equal average error limits for zero ... 56
4.5.4 Normal distribution of the error ... 56
4.5.5 Homogeneity of error limits ... 57
4.5.6 The Independence of independent variables from each other ... 57
5. CONCLUSION AND RECOMMENDATIONS ... 58
5.1 Findings and Conclusion ... 58
5.2 Recommendations ... 61
REFERENCES ... 63
ABBREVIATIONS
AAA :Accra Agenda for Action- ADF :Augmented Dickey-Fuller
AIDS :Acquired Immune Deficiency Syndrome ANDS :Afghanistan’s National Development Strategy BPHS :Basic Package of Health Services
CAREC :Central Asia Region Economic Cooperation CASA :Central Asia South Asia
CSOS :Child Support Online Services- CSOS DAC :Development Assistance Committee DCD :Development Co-operation Directorat FDI :Foreign Direct Investment
GDP :Gross Domestic Product GNI :Gross National Income
HIPC :Heavily Indebted Poor Country HIPC :Heavily Indebted Poor Country HLF-3 :Third High Level Forum
IFI :International Financial Institutions IMF :International Monetary Founds LCU :Local Currency Unit
MDGs :Millennium Development Goals MDGs :Millennium Development Goals NAS :National Academy of Science
NPISH :Non Profit Institutions Serving Households NRVA :National Risk and Vulnerability Assessment NSP :National Solidarity Program
ODA :Official Development Assistances ODI :Overseas Development Institute -
OECD :Economic Cooperation and Development PBHS :Basic Package of Health Services PRSP :Poverty Reduction Strategy paper
SIGAR :Special Inspector General for Afghanistan Reconstruction TAPI :Turkmenistan-Afghanistan-Pakistan-India
USAID :United States Agency for International Development USD :United States Dollar
WB :World Bank
WTO :World Trade Organization WWII :World War Second
LIST OF FIGURES
Page Figure 2.1: net ODA by the donors in 2010- as percentage of GNI ... 12 Figure 2.2: Net ODA in 2010 – amount by USD... 13 Figure 4.1: Time shift of Households and NPISHs Final consumption expenditure
per capita growth. ... 47 Figure 4.2: The time shift of subsidies and other transfers during 2006 - 2015 ... 48 Figure4.3: The time shift of Debt forgiveness grants during 2006-2015... 48 Figure 4.4: Time shift of the value of grants and other revenues during 2006 - 2015
... 49 Figure 4.5: Time shift of the value of net ODA received per capita during 2006 -
2015 ... 50 Figure 4.6: Autocorrelation and Partial Autocorrelation result. ... 56 Figure 4.7: Normal distribution test of error limits. ... 56
LIST OF TABLES
Page Table4.1: The most important descriptive statistical measures of the study variables
... 46
Table 4.2: Unit Root Test results of the study variables ... 50
Table 4.3: Results of the co Integration Test according to Johansson method ... 51
Table 4.4: Estimation of the regression model by the inclusion of lagged variables (one lag period) ... 52
Table 4.5: LM test results of self-correlation ... 55
Table 4.6: T-test results of the mean of the error limits of zero ... 56
THE EFFECTIVENESS OF FOREIGN AID TO POVERTY TRAP IN TERMS OF POOR COUNTRIES – CASE OF AFGHANISTAN
ABSTRACT
Foreign aid as external resources, mostly transfer from developed countries to under developing countries with the aim of boosting economic development. Based on economic theories, foreign aid to developing countries has positive impact and causing increment life standards and poverty reduction in these countries. In the other side, some economists criticize foreign assistances through outcome of these aid flows from the poor countries. These critics state that foreign aids by obtaining corruption and bureaucracy have negative effect rather than positive impact in developing countries. The debate on effectiveness of foreign aid is still ongoing while the consequences of the foreign assistances to the poor countries are under question yet. This research investigates on role of foreign aid in poverty alleviation and economic development of Afghanistan, using time series analyses covering a period of nine years (2006 to 20150. The study using secondary data and Households and NPISHs Final consumption expenditure per capita growth (annual %) has chosen as main variable for measuring poverty.
Afghanistan is one of the poorest countries in the world. The country has received huge amount of foreign assistance after 2001 which named the country one of the biggest recipient in the world, still suffering from poverty. Overall, the study funds that foreign aid has negative or no significant impacts on country situation rather than reducing poverty. The negative and insignificant results could be defined by increasing corruption, misallocation of the aids, donor driven and lack of ownership of the aids by Afghanistan’s government.
Secondly for the analysis of how aid can be made more effective in reducing poverty, empirical evidence suggests that institutional quality, control of corruption and trade openness are vital for aid effectiveness. Economic growth and trade openness have been found to be necessary conditions for poverty reduction.
Key Words: foreign aid, poverty, economic growth, poverty reduction, country
YOKSULLUĞU AZALTMADA DIŞ YARDIMIN ETKİSİ: AFGANİSTAN ÖRNEĞİ
ÖZET
Dış yardım, ekonomik kalkınmayı artırmak amacıyla çoğunlukla gelişmiş ülkelerden gelişmekte olan ülkelere transfer edilmektedir. Ekonomik teorilere dayanarak, gelişmekte olan ülkelere yapılan dış yardımın olumlu etkileri vardır ve bu ülkelerdeki yaşam standartlarının artmasını, yoksulluğun azalmasını sağlamaktadır. Diğer taraftan, bazı ekonomistler fakir ülkelerden gelen bu yardım akışlarının sonucu olarak dış yardımları eleştiriyorlar. Bu eleştirmenler, dış yardımların yolsuzluk ve bürokrasinin elde edilmesine yardımcı olarak gelişmekte olan ülkeler üzerindeki olumlu etkilerden ziyade olumsuz etkilerinin bulunduğunu belirtiyor. Dış yardımın yoksul ülkelere getirdiği sonuçlar henüz sorgulanmıyorken, dış yardımın etkinliği konusundaki tartışmalar hala devam etmektedir. Bu araştırma, dokuz yıllık bir süreyi kapsayan (2006-2015) zaman serisi analizi kullanarak, Afganistan'ın yoksulluğun azaltılmasında ve ekonomik gelişmesinde dış yardımın rolü ele alınmıştır. İkincil veri kullanılarak yapılan araştırma hane halkı ve Sosyal hizmetler ve Yardım kuruluşlarının, kişi başına düşen nihai tüketim harcamaları (yıllık%), yoksulluğun ölçülmesinde ana değişken olarak seçilmiştir.
Afganistan, dünyanın en yoksul ülkelerinden biridir. Ancak ülke, 2001'den sonra çok miktarda dış yardım aldı. Bu, ülkeyi dünyadaki en büyük alıcılardan biri olarak nitelendirmekte ve hala yoksullukla mücadele etmekte. Genel olarak, araştırmada dış yardımın yoksulluğu azaltmak yerine ülke durumu üzerinde olumsuz bir etkisi olduğunu ya da hiç bir etkisi olmadığı tespit edilmiştir. Olumsuz ve önemsiz sonuçlar, Afganistan’ın hükümeti tarafından yolsuzluğun artması, yardımların yanlış dağıtılması, yardımcının yönlendirilmesi ve yardımların mülkiyeti eksikliği ile tanımlanabilir.
Sonuçta, yoksulluğun azaltılmasında yardımın nasıl daha etkili hale getirilebileceğinin analizi için ampirik kanıtlar; kurumsal kalitenin, yolsuzluğun kontrolünün ve dışa açıklığın yardım etkinliği için hayati öneme sahip olduğunu göstermektedir. Ekonomik büyüme ve ticarete açıklığın yoksulluğun azaltılması için gerekli koşullar olduğu tespit edildi. Ekonomik büyüme ve ticarete yönelim yoksulluğun azaltılması için gerekli koşullar olduğu tespit edildi.
Anahtar Kelimeler: dış yardım yoksulluk ekonomik büyüme yoksulluğu azalması
1. INTRODUCTION
It is widely accepted that domestic capital is insufficient to promote the economic growth and development in developing and especially poor counties who are suffering from lack of internal capital and resources (Trinh, 2014). Foreign aid as one of the most potential external capitals play important role to boost the economic development in under developing countries. Foreign aid as external capital first started with the marshal plan as a post-war assistance in the late 1914s with the aim of reconstructing the war-torn economy of Western Europe (Moyo 2009). A successfully out-come of Marshall plan after the world war second (WWII) was enough to led the development of more optimistic idea about the role of foreign aid and its effects to the developing counties. In addition, the gap models and big push theory discussed that this thinking proposes such as aiding and transferring resources to the low incomes and poor countries could lead them to developing way as led the Western Europe Countries. Furthermore, foreign assistance became an essential prerequisite for economic advancement of the developing countries, especially while economy is moving out of “low-level equilibrium traps” (Hjertholm and White, 2000; United Nations, 2006). These general concepts caused the developed countries and international organization to provide large amount of aid to the low level countries with the aim of developing and reaching the desired level of economic growth. Therefore, developing and low level countries started to receive large amount of aid from both multilateral and bilateral sources. According to the World Bank, these two financial flows present with two main objectives; poverty reduction and promoting long term growth in developing countries and increasing short-term political and strategic interest of donor’s countries (World Bank, 1998).
Fallowing the decades of war, Afghanistan as a developing country re ceived huge amount of developing assistance. After 2001, the country continued to be one of major recipients of international aid in the world (World Bank, 2010). Based on Organization for Economic Cooperation and Development -
Development Assistance Committee (OECD-DAC) statistics, only United State donated net ODA to Afghanistan amounted to USD 118 billion, presenting the country as one of the largest aid recipient among the developing countries. according to the world bank database, net ODA as a percentage gross national income (GNI) is still significant and high relative to many developing countries (13.43% on average from 2000-2010 reaching a peak of 19.15 in 2003). Poverty in Afghanistan is in a severe condition. Among the population, 35.8 percent lived under poverty line in 2011, with 20 percent of the population just above the poverty line, where the risk of falling under the poverty line is dominant. The data in hand belongs to the year 2011, due to lack of data in either national or international level for the recent years. The National Risk and Vulnerability Assessment (NRVA) reported that 53.8 percent of Kuchis (Nomadic people in Afghanistan), 37.7 percent of rural population, and 28.9 percent of people living in urban areas are living under the poverty line.1 Poverty in Afghanistan defines to be a multi-faceted phenomenon, involving low assets (physical, financial and human), a long period of conflict insecurity and drought, poor infrastructure and public services.2
After the Second World War, foreign aid transfers started to the non-developed countries with aims of economic development and achieving desirable level of growth. Since that time, here is many empirical studies especially from African countries using periodic data, have been conducted on the impact of foreign aid (ODA). However most of these researches tried to investigate on aid -growth relation and consequently they have concentrated on the macroeconomic variables such as investment, saving, government expenditure that present economic growth (Siraj, 2002; Tadesse, 2011; Siraj, 2012). Unlike these researches, this study focuses on investigating aid’s effectiveness on its ability to reduce poverty in Afghanistan.
The economic theories are usually consistent to the pivotal role of foreign aid in spurring growth and development (big push theory), also studies conducted by
1 Afghanistan living condition, National Risk and Vulnerability Assessment 52. Available at:
http://www.af.undp.org/content/dam/afghanistan/docs/MDGs/NRVA%20REPORT-rev-5%202013.pdf.
2 Human Development Report, United Nations Development Program 2017. Available at: http://hdr.undp.org/en/countries/profiles/AFG.
Mosley et al. (2004), Gomanee et al. (2003), Asra et al. (2005), Masud and Yontcheva (2005) and Alvi and Senbeta (2011) have shown that aid has a significant result in poverty reduction in poor counties and significantly guided them to economic growth and development.
In contrast, opposing strand of literature argue that here is an insignificant or significant negative relation between aid and economic growth and even forei gn aid has negative impact on poverty as well. (Easterly, 2005; Magnon, 2012). The evidence shows that, many countries are still desperately poor after 50 years of receiving ODA. In many recipient countries the economic development processes were faster before receiving the official developing assistance. Furthermore, the critics state that international aid may support governments who are pursuing specific policies, and by increasing the power of these governments it may cause increment in corruption, tension and inefficiency in the society. Therefore, these factors easily can stop the development process (Salmonsson 2007). Additionally it is argued that if the assistance is free there is no responsibility and no incentive to use the aid productively (Dorn, 2004; Niaz, 2011). However, the debate on why it is not efficient and how aid can be effective and contribute to country's development is still ongoing without consistent conclusion (Estern, 2003).
There has been massive flow of foreign aid to Afghanistan since the inception of the new Afghan government in 2001. The outcome and effectiveness of foreign assistance to economic development of AFG are still under question and undesirable. Afghanistan is still struggling with poverty trap and lower economic growth.
This study investigates to explain the relationship between development aid and poverty reduction in Afghanistan. There are high volumes of literature on the impact of foreign aid on development in Africa and other countries. Studies conducted by (Mosley et al,2004), Gomanee et al. (2003), Asra et al. (2005), Masud and Yontcheva (2005) and Alvi and Senbeta (2011) etc. have shown that foreign aid had high impact on poverty reduction in poor countries and thereby helped significantly to their development progress. But there are only few studies about Afghanistan (Fayaz, 2012).
This study will fill the gap in the literature. In this study we will try to find foreign aid flows and their impact to poverty reduction in Afghanistan from 2001 up to 2016, whether the foreign aid efficient or not to the economic growth and country development in Afghanistan, what the relationship is between them. Furthermore, if it is ineffective, what are the reasons, what the government has done with receiving foreign assistance. Finally, try to propose some alternative ways to make use of foreign aid more efficiently to contribute to country’s development and poverty reduction.
1.1 Importance of Research
Foreign aid and poverty trap is one of the main economic topic especially for developing countries
To essential reasons why there has been massive flow of foreign aid to Afghanistan since the inception of the new Afghan government in 2001, however the outcome and effectiveness of foreign assistance to economic development of AFG are still under question and undesirable.
Lack of academic studies and research in this field.
It’s my interested field- related to my education background
1.2 Research Objective
Afghanistan is one of the poorest countries in the world. Mostly foreign aid considered as main external tools to boost economic growth in different countries. It is essential to conduct a scientific research on whether foreign aids have been effective or not in Afghanistan. The main objective of this study is to find the effectiveness of foreign aid on poverty reduction in Afghanistan. What the government allocated the massive foreign assistance, what has been the outcome of the foreign aid for Afghanistan, what are the reasons if it is ineffective, and are that any alternative ways to make use the foreign assistance more effectively to diminish the poverty and promote the country’s development.
1.3 Research Questions
What the effectiveness of foreign assistance to economic development in Afghanistan.
Does foreign aid alleviate poverty or not in Afghanistan?
What are the reasons if foreign aid is inefficient in Afghanistan development?
Does there any other ways to make use of the foreign assistance more efficiently in Afghanistan?
1.4 Research Implications
This study fills the literature gap of foreign assistance and economic development especially for Afghanistan.
This research will find out the reasons if inefficient of foreign aid in AFG to help the country escape the poverty trap.
This study will give policy makers and donors some suggestions to improve the effectiveness of foreign aid with the development goals.
1.5 Research Hypotheses First hypothesis
Null H0: There is no relationship between foreign aid and poverty reduction in Afghanistan.
H1: There is relationship between foreign aid and poverty reduction in Afghanistan.
Second hypothesis
Null H0: There is no relationship between foreign aids and household consumption per capita.
H1: There is a relationship between foreign aids and household consumption per capita.
2. LITERATURE REVIEW
This chapter is aimed to focus at the theoretical analysis of the most recent literature existence foreign aid and its effectiveness to the poverty reduction and country development. This chapter briefly describes the definitions of aid and Official Development Aid (ODA), the overall history and policies of aid, aid - poverty relations and review the three high level forum (HLF) regarding aid effectiveness. Furthermore, it continues to review the impact of these there HLF regarding aid allocation and its effectiveness on Afghanistan’s country development and poverty alleviation by both donors and government. Finally, the chapter ends with Afghanistan’s current profile.
2.1 Defining Aid
Before reviewing the history of foreign aid, having a brief explanation on the concept of aid would be meaningful to the subject. Like a nation’s foreign policy, this is not easy to define the foreign aid in sample way. Foreign aid, generally defines the nominal value of the indirect and direct financial flow subsequent to the sources provided by the developed countries to the poor or under developing countries. Foreign aid is the term that defines the flow of technical and financial resources to the under developing countries from the rich and developed countries. Foreign aid is the international transfer of goods, capital and services from an international organization or a country in order to benefit the population of the recipient country.
The foreign aid can presents in form of military aid, economic aid, humanitarian aid, or emergency aid to the recipient countries. Generally the type of foreign aid refers to the donor and recipient countries interest. Nowadays, as the developing process is not identical in developing countries, the concept of foreign assistances may change over the time.
Foreign assistance as external resources to the developing countries plays an important role, as Thomas Balogh says that:
from being a voluntary contribution by sovereign nations, is becoming slowly (as it is already within communities organized as states) a civic or human duty to contribute in proportion, or more than in proportion to wealth to the progress of the less privileged populations. Foreign aid will then become a conscious weapon controlled intestinally to combat poverty and inequality in an international framework. (Balogh, 1967)
Word ‘Aid’ commonly refers to the nominal value of direct and indirect financial recourses and cash flows from developed and rich count ries to the poor countries or developing countries. Based on the Tripathi definition, “foreign aid is the expression which mostly used to describe, the flow of financial and technical resources from the developed world to the under developing world” (Tripathi, 1981).
Additionally, foreign defined by Britannica Encyclopedia, as international transfer of cash flows, goods or services from a country or international organization with the aims of increasing life standards and social welfare to the recipient countries. These transfers can be in form of economy aid, military aid or emergency humanitarian aid (Williamson, 2011).
Humanitarian and non-humanitarian aid can be named as two main category of the foreign assistance. Humanitarian aid defined as grant at t he time of emergencies or after the emergency situation, donates to the recipient countries in order to protect human dignity, save lives and reduces suffering due to the humanitarian principles which are impartiality independence and neutrality. Prevention of disaster, water food, and sanitation services can be provided as humanitarian aid to save the affected people, in order to lead them toward achieving their normal life back.
In the other hand, non-humanitarian aid includes foreign assistances for development related to the socio economic factors that led to the crisis or emergency such as the debt relief scholarships and administrative costs (Williamson, 2011).
2.2 Official Development Aid
The ODA widely well known as foreign aids in economic literature s, which is aid given to combat poverty and to promote economic development. Official Development Assistances (ODA) named as most common type of foreign aids, which mostly donates with the aims of country development and poverty reduction the non-developed countries (Williamson, 2011). The most accepted definition of aid is defined by the Organization for economic Cooperation and Development (OECD). According to the OECD definition to the aids:
Flows of official financing administered with the promotion of the economic development and welfare of developing countries as the main objective, and which are concessional in character with a grant element of at least 25 percent (using a fixed 10 percent rate of discount). (George, 2009).ODA can present in form of bilateral agreement between two countries, and multilateral institutions. Furthermore, the ODA can be presented in form of financial resources; merchandise such as machinery and foodstuff; or as training and technical assistances, while it could be present in form of grants, debt relief and credits.
2.3 The History of Official Development Assistance
As the warring parties were looking for an ideal deal and strategically significant in the past, military aid named as the earliest form of foreign aids. In nineteenth and twentieth century, the European powerful countries decided to transfer huge amounts of money to their colonies. It was basically presented with the aims of buildings infrastructure and increasing the economic output of their colonies. (Williams, 2011). Once these cash flows had significant result to the colonies economic, the government of developed countries, interested to find the ways for the international political economy and the economic relations between the least-developed and developed countries. The foreign assistances with the aim of development to the Third-World countries were given more attention as part of the new dimension of economic relations.
Today, the modern scope and structure of the foreign aid can be sketched to the two main developments that took place after the World War II during 1944 -46. Firstly, it was the implementation of the Marshall Plan sponsored by USA, to
rebuild the 17 western and eastern Europeans countries’ economies. Secondly, to create the significant international organizations such as World Bank, international monetary founds (IMF), and United Nations (Williams, 2011). Promoting the monitory stability was the main for founding the IMF organization, while increment the capital for reconstructions Japan and European countries was the main reason to establish the World Bank. “Aid was viewed as a way of supporting ‘developing' country economies to industrialize, attracting large scale investments of capital and technical expertise that would lead to western style industrial development” (Aid Watch, 2011). In 1949, while industrialization and modernization was in progress ahead, the official development assistance mainly focused to dominant economic and political theories of the time. According to the US President Harry Truman, “to jump from poverty trap and economic problems, the underdeveloped countries have to speed up the progress for modernization and industrialization” (Aid Watch, 2011). Even though, the policies for industrialization and modernization were preferred by the under developing countries’ elites, cause “it proved largely disastrous for communities and environments mandated for development due to the power imbalanced between the IFI’s (International Financial Institutions) and recipient countries in Africa, Asia and the Pacific parties” (Aid Watch, 2011). In 1050-1960 once the decolonization were in progress, and newly formed independent states faced luck of industrialization: nations such as developed and developing countries has appeared (Emmerij, 2002). Once the impacts of foreign aid to the developing countries realized by the World Bank, United Nation and other non-governmental organizations they stated that, however the old format of development assistances positively impacted on economic growth it also had little but significant impact on social indicators such as poverty rate, life standards, sanitation services, infant mortality rate and education level as well (Aid Watch, 2011). Therefore, the donors and ODA organizations decided to concentrate more on effectiveness of the aid to the social indicators such as basic needs, gender quality, health care system, education institutions and income distribution rather than only focusing on indicators at the macroeconomic level. This mechanism is called as ‘basic need approach’ supported by president of World Bank McNamara as he stated, these mechanisms are against the industrialization/ modernization/ and import
substitution policies of the 1950s-1960s and the structural adjustment policies of the 1980s and 1990s” (Kipping, 2011).
In2000, the international community founded the organization of millennium development goals (MDGs).3 The MDGs created to analyze the aid allocation failure on poverty reduction in recipient countries. Additionally, it agr eed that the donors together set up an international action plan by increasing the amount of ODA to 0,7 % of GNI in 2015, towards reducing poverty in eight non -developed areas. (Aid Watch, 2011).
However, the development cooperation continued to change the form of ODA and it’s prospective as key factor toward improving life standards in developing areas to reach global development, while the outcome of ODA was not as desirable as director of DAC stated, “success in aid allocation has not always been evident: ambitious targets by donors and recipient, failure in co-ordination, failure in time management - and fragmentation in donating aid and political self-interest of donors have too often prevented aid from being as effective as desired” ( Development Co-operation direction directorate, DAC, 2011). Over 100 developed and developing countries together discovered that, why foreign aids were not generating the development results that they wanted to reach the MDGs. Therefore, guidelines and principles have been made by this corporation to improve aids effectiveness to the recipient countries. These guidelines and principles happened in continuous effort to increase delivery of aid, which marked by three formal events: the High Level Forum on Aid Effectiveness i n Rome, Paris and Accra in 2003, 2005 and 2008, respectively” (DAC, Development Co-operation Directorate, 2011).
Nowadays ODA named as main resource for supporting development countries. Annually developed countries donate over 100 billion to under develop ing countries for boosting the economic development and reducing poverty. However, in the recent years the amount of aid annually donated reached the maximum level of all the history, still many countries suffer from poverty in the world
Based on OECD annually report, US$ 119 billion dollars donated only in 2008, USD 119.6 billion dollars in 2009, and USD 128 billion dollars in 2010 which presents 6.5 % increment over 2009( OECD annual report, 2011).According to the figures 2.1 below, the largest amount of aid donated by United Kingdom, United States, France, Germany and Japan in 2010. Furthermore, the Norway, Sweden, Denmark, Luxembourg, and the Netherland continued to pass the United Nations ODA target which was 0.7 % of GNI. Additionally, based on figure 2.2 below, the maximum increases in real terms in ODA were recorded by Australia, Belgium, Canada, Japan, Korea, Portugal and the United Kingdom between 2009 and 2011 (OECD annual report, 2011).
Figure 2.1: net ODA by the donors in 2010- as percentage of GNI
1,11,09 0,970,9 0,81 0,64 0,560,550,530,5 0,430,410,38 0,330,320,320,290,26 0,210,20,170,150,120,32 0 0,2 0,4 0,6 0,8 1 1,2 N or w ay Luxe mb our g Sw ede n De nm ar k N et he rl an ds Be lgi um Un ite d K in gd om Fin la nd Ir el an d Fr an ce Sp ai n Sw ize rl an d G er ma ny Ca na da A us tr al ia A us tr ia Po rtuga l N ew ze al an d Un ite d St at e Ja pa n G re ec e Ita ly Ko re a TO TAL DA C Seri1
Figure Hata! Belgede belirtilen stilde metne rastlanmadı.2.2: Net ODA in 2010 – amount by USD
Source: OECD 6 April 2011/ (OECD, 2011)
2.4 Paris Declaration on Aid Effectiveness
2005, February, experienced the early changeover phase through the channeling the international aid by donors. The international community joined at the Paris High Level Forum regarding Aid effectiveness, which hosted and organized by French government and “Organization for Economic Co-operation and Development” (OECD), respectively, on the second of March, 2005. The coincidence of the conference and getting attraction of the aid in promoting development, in terms of the time, leads to investigate almost all aspects of the civil society (Organization for Economic Co-operation and Development, 2008). The conference mainly focused on the methods which provide money by donors could simplify easily. Furthermore, try to harmonize the work in developing countries since the existing provided aid was uncoordinated, unpredictable and non-transparent. Additionally, the donor priorities campaigned the aid process also it was administered through the donor channels; therefore; taking the head by developing countries become a problematic issue (Organization for Economic Cooperation and Development, 2008). The countries attended to the Paris meeting discovered a serious requirement for comprehensive reform in implementation of the aid to tackle the poverty.
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Furthermore, the Paris Declaration on Aid Effectiveness was an achievement of the Paris meeting which was endorsed by the donors, developing countries, multilateral donor agencies, the regional development banks, and the international agencies (Organization for Economic Co-operation and Development, 2008). The Paris Declaration illustrated a wide consensus in the improving of the efficient aid among the international countries, in additional, it properly symbolized as the valued assistance to developing countries, their goals, and the commitment alignment to the implementation of their national plans applying their own planning and implementation systems. The aforementioned declaration consists of 56 partnership commitments in order to improve the effective of the aid. In order to present a measurable and evidence -based method for tracking the progress of implementation as well a s development of aid-based projects, it is based on the 12 indicators. The declaration established five further mutually reinforcing principles that closely secured the effectiveness of aid. In the following subsections, the aforementioned principled are briefly described:
2.4.1 Ownership
In developing countries, taking the lead in development policies and strategies by the governments plays a vital role for maintaining a sustainable development. It is worth to note that the donors have a great share in building up the capacity of the developing countries to exercise the leadership by strengthening the local expertise, institutions, and management systems (Organization for Economic Co-operation and Development, 2008).
2.4.2 Alignment
In Paris declaration it was agreed that, the donors would allocate their assistances in congruous with the priorities outlined in national development strategies in recipient countries. It is clear that for managing the aid, the donors would apply the local institutes and procedures to create sustainable structures. Specifically, to result an efficient applying of the procedures for financial management, accounting, auditing, procurement, and monitoring, the donors would remain committed. Additionally, it agreed that country’s institutions and system should be used for it allocation. Using the recipient country’s system
provides assurances that foreign aid will be spending for agreed purposes, improve effectiveness of the aid by reinforcing the sustainable capacity to develop in the recipient countries, and increase the government accountability to its citizens and parliament in the recipient countries.(Organisation for Economic Co-operation and Development, 2008).
2.4.3 Harmonization
It is obvious that the harmonization plays a considerable role in order to avoid duplication and the high transaction costs involved with the poor countries; hence; it was committed that the donors would properly coordinate their development work amongst themselves. The coordination would be performed at the country level to priorities the needs of recipient countries. Furthermore, donors should focus more on supporting particular aid allocation strategies led by recipient government, rather than investing in multi individual projects in these countries (Organization for Economic Co-operation and Development, 2008).
2.4.4 Managing for results
The donors are going to concentrate more on the relationship between the aid and the impact which is created via a tangible difference on the lives of poor people. They require to connect the programming and resources of the country to the results after that orient them with performance assessment of the frameworks. To this end, it required development of the proper and efficient tools and systems to measure the impact. Moreover, it was est ablished that the partner countries and the donor agencies would cooperate in a participatory approach in order to strengthen capacities and demand of the country for results-based management (Organisation for Economic Co-operation and Development, 2008).
2.4.5 Mutual accountability
In Paris declaration agreed that, mutual accountability; transparency and responsibility by both donors and recipient towards aid allocation, implementation, outcome and the impact of aid were to be made available to the citizens and parliament of both countries. Furthermore, along with this five
principles and participant of Paris declaration on aid effectiveness, also estimating and measuring the progress of aid allocation agreed to set up through development indicators (Paris declaration on aid effectiveness, 2006).These indicators fall in various categories and summarized as below:
Operational development strategies for both partners Reliable country systems
Aid flows are aligned on national priorities Strengthen capacity by coordinated support
a. Use of country public financial management systems
Strengthen capacity by avoiding parallel implementation structures Aid is more predictable
Aid is untied
Use of common arrangements or procedures Encourage shared analysis
Results-oriented framework Mutual accountability
Based on the principles and activities outlined in Paris declaration in 2005, the first round of monitoring was done keeping in account the 12 indicators in 2006 in 34 countries. In 2008, the second survey was arranged in to 54 countries to calculate the progress with the aims targeted at the country level. This survey covered an amount of USD 45 billion dollars official development assistance donated in 2007. Based on the result of this survey, aid positively impacted on one third of developing countries which were surveyed due to the improvement in their government system for managing their funds. Additionally, 90 % of the donors had untied and developed their aid flows while their technical cooperation was adjusted with the developmental programs of recipient countries (Organization for Economic Co-operation and Development, 2008). However, the improvement in recipient countries were slow and not at expected level, the major of recipient countries created their develo pment strategy and significant effort to strengthen their national system, in many cases these strategy were not supported by the donors countries (Organisation for Economic Co-operation and Development, 2008).
Later these problems increased due to the fragmentation in aid allocation by the donors. Additionally, fragmentation in aid programs negatively affected governmental plan for strengthen the national system. In conclusion, the 2008 survey provided the facts towards problem which avoid improvement in some specific area, presented specific strategy to resolve these problems and to measure and follow up the progress towards development programs in recipient countries. Additionally, based on the evaluations of the some NGOs, the Paris declaration on aid effectiveness was not implemented as planned in the forum (EuroDad, 2008). To resolve this problem, Overseas Development Institute (ODI) stated that, “ a better monitoring must arranged between the Paris principles and development results as a sector level” (Overseas Development Institute, 2008).
2.5 Accra Agenda for Action
This meeting took in action with the aims of making Aid More Effective through the Strengthening and Use of National Systems. Accra meeting which called the Third High Level Forum on aid Effectiveness (HLF-3) was held in Accra city of Ghana in 2008. This meeting was continuing to the previous meeting regarding aid effectiveness which held at Paris and Rome. Mainly the aim of this meeting (HLF-3) was to accelerate the development progress towards the millennium development goals. More than 100 senior minister from the different countries, delegates of aids institutions such as the World Bank, European commission, the head of United Nations, member of non-governmental foundations, was attended the third high level forum.( Accra Agenda for action, 2008). Accra meeting mostly was prepared and organized by developing countries. Therefore, the meeting was more special and interesting for the developing countries. This forum like previous meeting took place against the changing in donors programs and landscape to the aids. Around 80 developing countries and fifty-four developed countries attended to the forum. While most of them participated in OCED’s survey of progress, which were against the Paris declaration targets in 2008. Civil society also took place in this meeting for increasing the aid effectiveness. More than 300 civil society groups like gross roots groups attended to the forum. China and India had counted as
most important donors to the global organizations, as they promised to fight against specific problems such as AIDS, Malaria and Tuberculosis in to developing countries.
Additionally, some private foundations such as Bill and Melinda foundat ion were stand along the civil society groups actively. These foundations promised to expertise the aid process to decrease the aid complexities, which happened in developing countries, by failover in managing the aid.
Generally, the main aim of HLF-3 was to encourage the constitution of broad foreign aids partnership, supported by the Paris declaration agenda and principals. On the third day of the third high level of forum (HLF -3) after discussions and a series of nine roundtables, the Accra agenda for a ction (AAA) was endorsed by the ministers of the countries and foundations ‘representatives. Donors recollect and reaffirm their Paris Declaration commitment to provide 66% of aid as program-based approaches. In addition, donors will aim to channel 50% or more of government-to-government assistance through country fiduciary systems, including by increasing the percentage of assistance provided through program-based approaches (OECD, 2008).
Based on the evaluations surveys in 2006 and 2008 regarding monitoring the Paris declaration, and huge contributions from developing countries, the Accra Agenda for Action (AAA) introduced three main areas which improvement towards reform was not desirable, and need to be speed up for a better outcome of the aids (Accra Agenda for Action, 2008). These areas are as follows:
2.5.1 Country ownership
Country ownership of the foreign aids mainly had pointed by the Accra Agenda for Action in 2008.
Based on the AAA agenda “the developing-country governments need to take stronger leadership of their own development policies and engage further with their parliaments and citizens in shaping them” (Accra Agenda for Action, 2008).
The donors promised to provide at least 50% of their development aid through the treasury of recipient government; furthermore, they also concluded the
specific rules apply for fragile countries like Afghanistan. Finally, donors should respect the priorities of recipient countries for investment by allocates the aid on human resources and institutions, great improv ement to their system to deliver the aid properly, and lastly predictability of the aid by the recipient should be increased (Accra Agenda for Action, 2008).
2.5.2 Building effective partnerships for development
Based on the AAA, Aid is about to creating partnership for developing. To make this partnership more effective, it needed to harness the whole energy, abilities, skills and experience of all the development players such as bilateral and multilateral donors, global organizations, CSOS, and private sector s. This partnership is needed to support developing countries to build their future, increase economic growth rate and to reduce poverty (Accra Agenda for Action, 2008).
2.5.3 Gaining development results
In third high level of forum regarding aid effectiveness in Accra Ghana, donors and international organizations concluded that, donating aids to the recipient countries should end up with development result and openly accounting for them. These two goals presented as main aims of the donors and international organizations in AAA Ghana. Furthermore, donors promised to demonstrate that, their action will have positive impact on people’s life in recipient countries, and both donors and recipient will be accountable to each other, their peoples and to their parliaments for the outcome of the aid. Finally, donors and international comities agreed to accelerate progress on these three challenges: i: to strength country ownership over development in recipient countries, ii: creating inclusive and more effective partnership among the donors and recipient country, iii: increase delivery and accountability of the aid for developing result in developing countries. (Accra Agenda for Action, 2008).
2.6 Important Items of AAA from Afghanistan’s Perspective
Going through the outcome of Accra agenda and keeping in mind the situation of Afghanistan; can say that there are still many things need to change and more
to be done. However, the aims which determined by donors in Accra seems to provide great future for the recipient countries, from Afghanistan prospective the important items are those which can develop the country system for aid allocation, to increase the country development and reduce poverty. Following items from Accra agenda can set to the country situation to achieve the ab ove purpose in Afghanistan.
2.6.1 Country’s ownership over development
Development aid can be effective to the recipient while its county driven. Ownership of the aid should be to the recipient country rather than donors. By having this, country cans strength its financial management system, priorities capacities need develop in the country and then can allocate the aid through this channel to make it more effective. Therefore, donating the aids by the donors should be through on budget channels in Afghanistan, rather in individually investment. Additionally, by having the ownership of the aid, government can develop the local procurement to encourage private sectors for investing to the country.
2.6.2 Building of country’s institution
Afghanistan as recipient should support by donors to build its own institutions such as: institutions for aid allocations, prioritizing the area for investment, and research center to move ahead and led the country to the development activities. The recent conflict made the situations fragile in Afghanistan, creating these kind of institutions will also increase the government performance.
2.6.3 Poverty
Poverty is a phenomenon with multi definition. According to the World Bank, poverty word refers to the people living without access to the basi c and necessary resources for covering their basic needs such as food, drinking water and shelter. Poverty line is the measure of absolute poverty related to the $1.25 or $2 a day. The 1.25 poverty headcount ratios defined “the percentage of the population living on less than $1.25 a day at 2005 international prices” (The World Bank Group, 2012). Here is a corresponding definition for $2 poverty line. The measures are designed for purchasing power parity, which means
people living with the low level of life standard as calculated for all people living on less than equivalent of $1.25 or $2 a day in United States. The more comprehensive measurement is poverty gap index which takes into account the depth of poverty not just its incidence and this defined as “the mean shortfall from the poverty line (counting the non-poor as having zero shortfall) as a percentage of the poverty line” (The World Bank Group, 2012). The squared poverty gap also discuss inequality among the poor people, and puts more weight to individuals fall far from the poverty line than people close to it. It means that inequality is punished in terms of higher squared poverty gap. These are the easiest definitions if poverty but in the same time can be useful enough because they make the poverty and poverty reduction to be monitored and evaluated efficiently. Furthermore, the World development indicators (except squared poverty gap) state that, these are the most common measure to calculate poverty and used in lots of empirical studies. Poverty as a multidimensional phenomenon shows that most of the developing and poor countries are not just poor with the economy; they also facing lack of facilities in health sector, facing problem in security sector, poor in education sector, poor in political participation and many other aspects of life (OECD).
2.7 Poverty reduction
Based on poverty definition, people at the far down under the poverty line with $1 or less a day stay more poor with less access to basic needs of normal life, while people close to the poverty line(but still under poverty line) with $1.5 - $2 a day satay in a better situation than the first group however still suffering with poverty, and people above the poverty line, as far as they stay above the poverty line they have better access to the resources and lives’ standards. Therefore, poverty reduction can easily define as reduction in poverty measurement such as poverty gap index or poverty headcount ratio. Referring to the head count ratio, poverty reduction is quite easy to achieve by simply moving people closest to the poverty line from direct below it to direct above it (OECD, 2011). Even though, it will not grant giving better live to the people but will help the poverty statistic to look in proper way. This argument means that headcount measurement could be easily arranged or a better word manipulated,
therefore the poverty reduction should be measured with the other methods as well, (barder 2009).
In addition to, Barder argue that the type of poverty reduction needs to distinct and distinguish the possible trade-offs between current and future poverty reduction, deep poverty reduction and temporary and sustainable poverty reduction, while lots of researches without focusing on this fact of poverty reduction, finding and reasoning throw the economic growth and increases in GDP per capita which can be so surface and cant present the poverty reduction in reality (Barder (2009).
2.8 Aid-Poverty Relations
2.8.1
Theoretical link between foreign aid and povertyForeign aid as new phenomenon to the economic lessons, having been formalized in 1947 while the economists began to search and discuses about it as new indicator effecting developing countries and its impacts and the relation with the other economic factors in 1950s. Nurske and Lewis as earlier theorists present the foreign aid as external capital can provide efficient resources to boost developing countries into sustainable economic growth and to achieve desirable level of economic growth (Nurske, 1953; Lewis, 1954). While McGillivray mentioned that there was no imperial studying which proves the impact of foreign aid and its relation with the poverty reduction in 1947 McGillivray et al. (2006). In this section try to explain the main theories of economic development and justify the importance of the foreign aid, aid - poverty relation and the effectiveness of the aid to poverty reduction and economic development.
2.8.2 Vicious and virtuous cycles
An investigation to find the reason why some developing countries faces growth failover and the reason why poverty seemed to be self-reinforcing has been discussed by some theorists like Rosenstein-Rodan, Murphy et al, and Schaffner. It was argued, that here is one or more vicious circles which make underdevelopment and poverty more sustainable and has the impacts on failing the Economic growth and holding the economy in low incom e which can be the
reasons for raising poverty traps (1943), Murphy et al. (1993), (Schaffner, 2014), (Clunies-Ross et al., 2009, p. 109). While in the other side, the vicious cycle has been criticized by some theorists such as (Myrdal, 1957; Fujita, 2004; Perry, et al., 2006).and state that, here is the virtuous cycle which is opposing the vicious and argue that, not that this cycle will push the developing country to fail in growth even will lead these countries to economic development by this cycle. Furthermore, Perry discussed that, “virtuous circles’ were thought to be opposing, which promote growth by setting into motion Self-reinforcing income-raising systems that function through ‘circular and cumulative causation” ( Perry, et al, 2006). Based on the Clunies-Ross et al. (2009, p. 109) “a typical vicious circle would see initial low productivity levels leading to low per capita income levels … places a very low ceiling on attainable levels of savings -which, in turn, rule out the new capital investment needed to improve productivity. The economy is stuck in (a) low-productivity and low-income trap”. Thus, the ‘vicious and virtuous cycles’ theory can be termed the “poverty trap model” (Murphy, et al., 1989). This theory explain that here is a wide range of vicious circles, which fail attempts by the poor countries to jump from poverty trap, and even take the national growth performance down (Clunies -Ross et al., 2009, p. 110). Furthermore, it emphasis that the poverty outcome may prevent people to go out of it and cannot have effective attempts. Therefore, many economists argue as solution to jump out from poverty trap “a special effort to push the economy over a threshold into a region where sustained increase in per capital incomes is possible” (Clunies-Ross et al., 2009, p. 111).
Based on the finding of Solow (1970) there is a high demand for “a major burst of investment [to] lift the system into a self-generating expansion of income and capital per head”4. to creating a sustainable growth and destroying the poverty, increasing the rate of aid and direct investment was suggested as main solution to the problem. Furthermore, suggesting that developing countries need a ‘big push’ to defeat limitation and rule out from the low-level trap. (Rosenstein-Rodan, 1943; Clunies-Ross et al., 2009). In addition to this, it argued that the outcome of efforts to promote growth is successful if we attempt to reduce poverty and improve income distribution in the same time. Foreign aid as
engine of economy to developing countries would cover the much-needed increase in investment. Therefore, the main argument that foreign aid would “jump-start economic growth, and initiates a virtuous cycle whereby investment generates income and thus raises the economic return to further investment” (Shleifer, 2009, p. 381). Have a look also to (Roser Ortiz -Ospina, 2017) and Niyoncuru (2016) for more details and discussions on the measuring of poverty in the world.
2.8.3 Stages of economic growth theory
The ‘stage of economic theory’ firstly presented by Rostow, and states that If poor countries want to have stable growth and achieve the development goals they should have pass a series of stages as key of success to reach this destiny, (Rostow, 1960;1990). The stages start with the traditional society while low level of economic growth rates presented as main character of the society and agriculture sector as main part of the activities involved 75 percent of the population. Transitional stage as second stage of the theory, emphasis on incensement of efficiency in agriculture sector and more focuses on general modernization of the economic at the macro level. The third stage which is a critical stage in development process called take-off. The theory states, that take-off stage supposed to be resulted as huge increase in the level of saving and investment, and help the society to adopt more with the modern production’s technologies (Clunies-Ross et al, 2009). The fourth, fifth and final stages of the theory are ‘drive to maturing’ and talk about high level of consumption respectively. For long time, this theory was widely accepted as ‘road map’ which means developing countries to achieve the development goals should pass through this road and successfully pass these stages while foreign aid justify as main factor to help poor countries take off, (Clunies -Ross et al, 2009). According to Esterly and Rostow “an increase of $4 Billion in external aids would be required to lift all of Asia, the Middle East, Africa, and Latin America into regular growth, at an increase of per capita income say, 1.5% per annum”. Easterly (2006, pp. 24-25), Rostow (1960)
2.9 Harrod-Domar and Gap Models
According to easterly (1997), harrod-Domer model is widely presented by development economists and aid policy makers to calculate the amount of aid need to be allocated to developing countries with the aims of development and increasing the economic growth rate.
This model is mainly inspired from the Keynesian analysis of economic growth model presented by Harrod(1939; 1948) and almost the same but individualistic study by Domar(1945).
Equation [1] shows the Harrod-Domer equation and relationship to the model. g = S V⁄ (2.1) Where g is growth rate of income in the Economy, S as savings rate of economy (available savings) and V is the capital output ratio?
Excess in supply of the labor in economy presented as main assumption of the model, availability and productivity of the capital present as main factors effecting economic growth and level of savings will determine the level on investment to the economy (McGillivray et al, 2006). However, the creators of Harrod-Domar model was not clarifying this as main intention of the model, while development economists to find and specify rate of economic growth was using the Harrod-Domar relationship by estimating the saving-investment rate to the economy. (Clunies-Ross et al., 2009) For example, Hussein argue that once estimate the capital-output accurately, it’s possible to predict the growth rate which given the current saving rate. In addition, to achieve a targeted growth rate we can estimate the savings rate which needed for that special level of growth. Therefore, once the capital-output ratio(V) was assumed to be constant, the theory mainly states that, higher the savings - the higher growth rate in economy. (Hussain, 2001). McGillivray defines the foreign aid allocation and state that, with low level of savings (usually exist with poor countries) can have only preferred rate of economic growth, then here is ‘financing gap’ needs to be solved and led the country to desired rate of economic growth. The different between total required investment and available domestic savings in the society will determine the ‘investment gap’ and level of
foreign aid need to be allocated to fill the financial gap in the economy. Therefore, foreign aid could be used to eliminate the savings limitation in the society, increase the level of available investment, increase the rate of economic growth and finally will reduce poverty (McGillivray et al., 2006). in 1962 -1966 the Harrod-Domar model has extended from the savings-investment gap to foreign exchange gap by Chenery and Bruno. The theory presented as ‘tow gap model’ (or dual- gap model). The foreign exchange gap stated that, developing countries in order to achieve the desired level of growth rate, they have to focus on importing the high quantities of capital goods and other essential inputs to increase the level of production. (McGillivray et al, 2006). Furthermore, it argued as there is no export earning for developing countries, they have to use the capital good for investing and covering the financial gap. (McGillivray et al, 2006). Based on the main assumption of two-gap model, ‘the local savings could not easily be turned into foreign exchange, at least in short run’. Therefore, the foreign aid would play two roles: boosting the available resources for investment and supplying the desired level of foreign exchange to the economy. According to Hussain, the World Bank economists by using the Chenery version of Harrod-Domar model and similar updates of this were estimating the economic growth for more than 90 percent of the countries in the World Bank and resource requirement predictions. Hussain (2001, p. 2).In 1990, Taylor and Bacha presented a third gap which called ‘fiscal gap’. The fiscal gap mainly argue that some developing country governments to reach the desired level of investment, they don’t have the “revenue raising capacity” therefore, foreign aid given directly to the recipient governments can easily cover the fiscal gap and help the countries to increase the level of investment. (McGillivray et al, 2006).
In conclusion, the Harrod-Domar and the gap models were used to explain the importance of foreign aid to the developing countries and to estimate the amount of foreign aid need to be allocated. By Using the three-gap models (the savings-investment, the foreign exchange and the fiscal balance gap), it was argued that foreign aid would supplement the low savings and therefore increase the level of investment funds, provide the foreign exchange needed for the importation of crucial capital goods and inputs, and boost domestic revenues.
